Dollar Softer As Markets Await Bernanke Speech

From the BBH Currency Strategy Team

Highlights

The US dollar is mostly weaker vs. the majors but remains in very narrow trading ranges ahead of the weekend. EUR/USD is still having trouble moving above the 1.27 area, and is likely to continue having trouble given stresses in the periphery (see below). The yen and Swiss franc are largely weaker today as well, but it doesn’t really feel like a risk on trading day given higher bonds and lower stocks being seen in European trading. Market sentiment remains jittery, and so we expect further swings in market sentiment as we move into September. EM currencies are largely softer. Biggest gainers vs. USD so far today are SEK, NZD, CZK, NOK, and AUD, while the biggest losers are ZAR, KRW, ILS, JPY, and IDR. US data out today (Q2 GDP revision, see below) could see another hit to sentiment.

Asian equities were higher, with the MSCI Asia-Pacific Index posting a modest 0.3% gain today. Singapore, Taiwan, and Thailand outperformed on the day, while India, Indonesia, and Philippines underperformed on the day and ended lower. Nikkei 225 posted a 1.0% rise and is flirting with the 9000 level and helped by the softer yen. European bourses are trading higher so far today. US shares are looking for direction after the last two days of volatile trading, as futures trading points to modest up opens for the major US indices.

Core euro zone bond markets are slightly firmer due to ongoing tensions in the periphery. Peripheral spreads to Germany have widened back out today and remain at or near historic highs for some. The Portugal-German spread is the big mover today, up 8 bp to a record +334 bp. Ireland spread is up 7 bp to a record +353 bp, while Greece, Italy, and Spain 10-year spreads are wider by 2-3 bp today. Short end of the curve is getting hit even more. US Treasuries are softer ahead of Bernanke’s speech today, with 10- and 30-year yields up 2-3 bp on the day.

Currency Markets

The euro tries to build on its bounce vs. the dollar but continues to trade heavily above the 1.27 area. Peripheral bond markets remain under pressure, and should serve as a reminder as to why the euro upside is limited. Portuguese bonds are underperforming across the curve today, and we note that this past week, a different peripheral country seems to be under pressure each day. Interestingly, an EU poll showed that Portuguese citizens disagreed most with the need for deficit reduction. Eurobarometer survey found 59% of Portuguese agreed that deficit reduction measures in their country “cannot be delayed.” This percentage was the highest in the 27 EU member states, where the average was 74%. The survey was carried out in May, with 1,025 people interviewed in Portugal. As the economic outlook deteriorates and fiscal headwinds bite, we would expect these numbers to decline, not just in Ireland but across the euro zone. We continue to believe that Ireland developments this past month were key in turning market sentiment negative again. Ireland, the country that had done everything right with regards to austerity, was still downgraded and markets were unnerved that the cost of adjustment in Ireland was still mounting. The thinking goes that if Ireland is facing trouble, how can countries such as Greece and Portugal make it work?

Lots of attention will be given to Fed Chairman Bernanke’s speech today at the Jackson Hole Symposium. But really, what can he say that we don’t know already? Yes, the US economic outlook has deteriorated. With an FOMC meeting in less than a month on September 21, is this really the time for the Fed chief to signal a major policy shift? He will undoubtedly play up the fact that the major central banks remain in constant contact with each other, but we still downplay the actual degree of cooperation. Right now, it seems like every country for itself with regards to policy. Sure, Japan is trying to get the US and Europe on board to do something about the yen, but it is not seen as a G3 problem, but rather as a Japan problem. Bernanke will likely say that the Fed stands ready to act as needed, and may elaborate further on the Fed’s recent decision to keep the size of its balance sheet unchanged to prevent passive tightening. But announcing any new measures? We find it extremely unlikely.

The yen softened late in the Asia morning after Finance Minister Yoshihiko Noda made further comments about the yen’s strength, and slightly confused reports that PM Naoto Kan would address the currency situation in a briefing at some point today. There was an initial report in Kyodo News saying that Kan would call a special press conference on the yen, before chief cabinet secretary Sengoku said that Kan would be speaking on economic policy and the yen at an event in Tokyo. FX Noda said the currency situation is ‘severe’ and that the government would take appropriate action when needed. As we’ve said before, any intervention by the Japanese authorities would likely be ineffective as it would be unilateral. In our view, the strong yen is simply not the threat to global growth that it might once have been (see 1995, when G7 issued statement calling for orderly reversal of the weak dollar/strong yen), and so it’s unclear why the US or Europe would be dragged into intervening, and we don’t see a lot of potential cooperation between central bankers right now as we explain above. And as the SNB can tell the BOJ, unilateral FX intervention is highly unlikely to do much except slow the move, not reverse it. Meanwhile, Japan’s economic outlook remains poor. Consumer prices declined for the 17th straight month, while household spending rose less than forecast. The unemployment rate, however, fell for the first time in six months. Prices excluding fresh food fell 1.1% in July from a year earlier, after a 1% drop in June. Tokyo prices ex-fresh food for August also saw a drop of 1.1%. Household spending climbed 1.1% in July from a year ago, up from 0.5% a month earlier, but less than the 1.5% growth expected. The jobless rate unexpectedly fell to 5.2%, when the consensus predicted staying at 5.3%. The job-to-applicant ratio rose to 0.53. We know the government is working on further stimulus measures, but their hands are very much tied right now. Add in political uncertainty and it will be tough to get a comprehensive package done soon, in our view.

While today’s Q2 GDP revision is going to get the headlines, we think analysts are quietly marking down Q3 and Q4 expectations now. Market is looking for 1.4% revision from 2.4% previously for Q2. Bloomberg consensus has Q3 and Q4 growth at 2.5% and 2.6% annualized currently. However, the July data has so far come in very disappointing and we foresee H2 markdowns if this trend continues. Business investment in plant and equipment was one of the positive surprises in Q2, and Q3 is likely to show slowing in this category in light of weak durables data for July. One market contact said that his 2.0-2.5% Q3 forecast is dependent on robust business investment, and that if data is weak in August, he may have to mark it down to 1.0-1.5%. This sort of trend would tend to support the risk off trading environment, and we note that currency and equity volatility tend to pick up in September and October and so the near-term outlook is dicey for risk assets.

Upcoming Economic Releases

At 8:30 EST/12:30 GMT, US reports Q2 GDP revision, which is expected at 1.4% SAAR vs. 2.4% initially. At 9:55 EST/13:55 GMT, University of Michigan consumer confidence will be reported, and is expected to come in steady at 69.6 for August. Peru reports Q2 GDP today, but no time is scheduled. At 10:00 EST/14:00 GMT, Fed’s Bernanke speaks on the US economic outlook at the Jackson Hole symposium.